Ask Harry #8: Why do the majority of acquisitions fail and how to avoid failure?

One of Kellogg’s first and most popular executive programs is “Merger & Acquisition Week.” It was started by Professor Al Rapport more than 50 years ago. I am fortunate to teach a section of the course that I call “Lessons from the Battlefield.” I remember as a Kellogg student reading that almost 80% of acquisitions did not earn their cost of capital, that is, the acquiring company’s shareholders would have been better off if the acquisition had not taken place. Interesting enough, the success rate has not changed much in the past 50 years.

I will summarize the seven major reasons why I believe so many acquisitions fail and what you can do to avoid failure and increase the success rate.

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Reason #1: Many companies don’t realize what they are really good at.

By failing to understand their strengths, they make assumptions and get into areas where they have no competitive advantage. I often tease executives that they may think they are really good in 8 or 9 areas, but they are only really good in 2 or 3. And by the way, that isn’t a problem since many companies are not good at anything, which is why many companies don’t survive for very long.

Lesson#1: Make sure you know what you are really good at, and stick to it.

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Reason #2: Many companies don’t understand the economics and how to determine the value of a company.

This is an issue that Professor Rappaport drilled into us at Kellogg. The value of a firm is not determined by accounting EPS and PE multiples. Rather, the value of a firm is determined by deriving the present value of future cash flows. Once again, take a look at his book, “Creating Shareholder Value.”

Lesson#2: Take the time to understand the real economic drivers of company valuation.

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Reason #3: Leaders state the acquisition is “strategic.”

I once asked an executive why he wanted to make an acquisition, and he responded that it was “VERY strategic.” When I questioned if the acquisition was economic, he responded that the acquisition was “strategic way beyond present value.” I had to explain that there is nothing “beyond present value.” 😉

Lesson #3: If it is not economic, it is not strategic!

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Reason #4: Companies let bankers decide what the target company is worth.

Don’t get me wrong. Bankers can be very helpful by determining if a company may be available and what price the company is willing to sell for. However, to determine the economic value of the target (growth, margins, expenses, tax rates, discount rates, etc.) requires significant detailed work from operating managers who know the industry fundamentals in detail.

Lesson #4: Operating management must determine the value of a target, not bankers.

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Reason #5: Buyers get emotional in pursuing an acquisition.

The one thing one should never do in pursuing an acquisition is get emotional. Yes, you may want to make the acquisition. However, if you define “winning” as paying more than anyone else, you may win, but your shareholders most likely will lose. It is usually a bad sign if the target is pushing you to move quicker than you believe prudent to really understand the economics. Try not to convince yourself that “we must have this company.” There are usually other possible candidates that may be more economic.

Lesson#5: Never get emotional in pursuing an acquisition.

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Reason #6: Many companies ignore the cultural fit.

Even if a company is successful with the first five issues, the lack of cultural fit can lead to disaster. The economics may be compelling, but you must ask yourself if the culture of the two companies is compatible. Can a company run by engineers and manufacturing managers coexist with a company run by sales and marketing managers? Every time I hear the expression “merger of equals,” it reminds me of “jumbo shrimp”: it’s an oxymoron! Beyond the numbers, it is critical to take the time to determine whether the two companies can come together as one.

Lesson#6: Make sure there is a reasonable cultural fit.

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Reason #7: Many companies fail to understand the importance of timely integration.

Think of how often you see a company make an acquisition and announce that they will take six to nine months to integrate the two companies. Then the acquiror wonders why so many of the acquired company’s people leave. I use a very simple formula: change + uncertainty = chaos. Yes, an acquisition will clearly create change. However, you better do everything you can as quickly as you can to minimize the uncertainty, or the acquisition will fail

Lesson#7: Integrate the two companies as quickly as possible. If you aren’t sure of the answer, guess, and correct later.

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Summary of 7 Lessons to Minimize the Risk of Post-Acquisition Failure

Lesson#1: Make sure you know what you are really good at, and stick to it.

Lesson#2: Take the time to understand the real economic drivers of company valuation.

Lesson #3: If it is not economic, it is not strategic!

Lesson #4: Operating management must determine the value of a target, not bankers.

Lesson#5: Never get emotional in pursuing an acquisition.

Lesson#6: Make sure there is a reasonable cultural fit.

Lesson#7: Integrate the two companies as quickly as possible. If you aren’t sure of the answer, guess, and correct later.

In being involved in many acquisitions, I have found that abiding by these lessons significantly increases the overall success rate of an acquisition. Good luck!!!!